Identifying whether your auto insurance claim is taxable is necessary before deciding how to distribute your settlement proceeds. Although it adds a further layer of complexity to your injury claim resolution, it also avoids potential problems down the road. You may be assured that whatever your future plans entail, there won’t be any unexpected tax issues.
Settlements from auto insurance policies are typically not subject to tax. You might have to pay income tax on some of the settlement, though. While your personal injury lawyer can analyze fundamental tax matters, you should also see a tax expert for additional advice.
Taxable Settlement Income as Defined by the IRS Revenue Code
The U.S. Federal code eCFR §1.104-1(c) establishes settlement taxability guidelines. The provisions explain that “in general” damages for “personal physical injuries or physical sickness” are not taxable. As most people never get around to reading federal statutes, the IRS provides supplemental information on their website under the topic, Court Awards and Damages.
They also provide this information in a simple, user-friendly bulletin format. Publication 4345, Settlement Taxation explains the exceptions to the non-taxable rule. It also provides brief explanations as to the rationale behind the guidelines.
Vehicle Accident Insurance Settlements in Certain Amounts Are Taxable
The phrase “personal physical injuries or physical disease” used by the IRS to describe non-taxable settlement income is precise and intentional. According to this concept, settlement money that results from a physical illness or damage is often exempt from taxation. Types of settlements that do not meet the requirements for non-taxable status are listed in Publication 4345.
When you consider that they also apply to injury claims resulting from vehicle accidents and other types of incidents, IRS designations of taxable vs. non-taxable claims make more sense. They include claims for workers’ compensation as well as non-physical personal injury claims for things like slander, defamation, and claims based on discrimination or wrongful termination.
Car accident injury settlements are often not taxable, but it can be challenging to make that conclusion. A settlement can frequently include both taxable and non-taxable proceeds. You must familiarize yourself with these IRS rules in order to understand the discrepancies.
Depending on the circumstances, a settlement for emotional distress or mental anguish may be taxable.
The compensation is not taxable when bodily ailments or injuries result in discomfort or agony. If a compensation for psychological harm is not connected to a physical illness or injury, it is taxable. For instance, the IRS considers the settlement taxable income if a person merely has emotional damage as a result of an accident (PTSD, mood swings, or chronic depression).
Taxes Apply to Exceptional or Punitive Damage Awards
In Nevada, jurors have the power to compensate an injured party with punitive and exemplary damages. Due to the fact that it does not compensate the plaintiff for actual injuries, this amount of their claim is taxable. For deceptive, malicious, or oppressive activities committed by the defendant, punitive and exemplary damages may be awarded.
You can owe a portion of medical expenses that were previously written off on previous tax returns.
You might have been eligible for a medical tax deduction in prior years if you had discovered accident-related medical expenditures. These expenses turn become taxable income if the liability insurance provider includes them in your vehicle accident settlement. When you get payment from your settlement, the IRS permits you to declare these expenses as prorated income if you deducted them over a number of years.
An auto injury settlement’s wage settlement portion is not taxable.
Although the regulation is different for other types of settlements, lost wages associated with a vehicle accident injury settlement are not taxed. Back earnings are taxable if you get them as part of a settlement for wrongful termination, discrimination, or any type of non-physical injury. You can also owe Social Security and Medicare taxes if you get a taxable income settlement based on earnings.
Some of the compensation for lost business profits is taxable.
Your business or freelance gig employment may potentially be placed on hold if you sustain an injury in a car accident. The expenses you incur to keep your company going can be claimed as a loss of profit. The IRS treats your business continuing expenses as taxable income if the liability insurance reimburses you for your lost earnings and related costs.
Your settlement’s interest income is taxable.
If you’re like most people, you’ll put your settlement money in an account with the highest interest rate. That’s a good thought, but you should be mindful of how your tax situation is impacted by your earned interest. Whatever interest or income you make is taxable, even if your settlement isn’t.
Your health insurance tax credits may change if you receive a taxable settlement.
If you purchase health insurance via Nevada Health Link or another federally supported marketplace, a rise in your taxable income could result in an additional tax problem. As advance premium tax credits are determined by your income, a rise in your income may have an impact on them. The IRS advises notifying your health insurance marketplace when you obtain a settlement from your auto insurance policy in order to prevent significant rate increases in the future.